November, 2016

This week, I’ve had an argument with a conservation biologist whose position is desert tortoises are invaluable and the power utility is evil therefore we should not have large scale solar and do the rooftop solar instead.

My position was that before deciding what we consider should include but not be limited to the tortoises. However, attaching a value to tortoises wouldn’t necessarily be so straightforward.

She was too polite to say it but she probably thought I was lost cause who is clueless about how amazing the nature really is…

Therefore, it’s official.

I’m a grown up economist now!!

What are you thankful for?

Let’s back up a bit.

It is about the net metering drama in Nevada.

Perhaps you’ve heard it. You can read about it in the most recent working paper written by Jeanne Wendel, Tom Harris, and yours truly.

It’s the one where actor Mark Ruffalo was screaming at the PUCN commissioners at the hearing room.

By the way here is my open letter to him:

______

Dear Mr. Ruffalo,

You are a great actor.

However, you don’t know any economics.

Sincerely,

______

Net metering (NEM) is an arrangement between a power utility and its customers where the customer generates electricity onsite for own use [think: mostly rooftop solar panels] and exports the unused portion into the local grid and gets credited for it.

In Nevada, and in many other states NEM started out and stayed at minuscule levels for many years.

Then the climate change happened and the governments started giving out rebates and subsidies for renewables.

Also, technology and learning by doing brought down the costs tremendously.

Then, all of a sudden, rooftop solar became a possibility for many middle or upper middle class Americans.

As the take up started to soar, two main economic concerns started matter.

First is regarding how much compensation should be given to NEM exports.

In Nevada, the credit the NEM customers got per kWh was the same as retail electricity price.

What this means is that the utility was effectively buying electricity from the NEM customers at the retail rate (~12 cents/kWh) while they could be buying the same electricity from the wholesale markets for MUCH cheaper (as low as ~2 cents/kWh).

This of course increases the costs, which the utility has the right to pass on to the customers. [think: rate hikes for ALL]

The second one is about basic service charge.

Being a power utility requires investing a ton of money into generation, transmission, and distribution infrastructure to be recovered through the rates overtime.

On your bill, you’ll see a “basic service charge” and a “consumption charge”.

Not just the basic service charge but also a good portion of the consumption charge goes towards covering the capital investments.

These rates are designed back in the day so that large customers would be covering more of the capacity investments

[think: proportionate to their consumption]

So if a NEM customer starts to consume less energy from the grid, she would be paying less in consumption charges and therefore would be contributing less to the overall capital recovery.

**This is true even though the basic service charge is still intact.**

Therefore, some of the capital costs will remain uncovered [again read: rate hikes for ALL].

An important detail is that NEM customers [**on average**] are richer than the non-NEM customers [source] which makes such a cost shifting extra annoying.

With all these concerns in mind, PUCN ruled to divide the customers into classes.

The NEM class will now pay higher basic service charges and be credited less for their grid exports.

This is what led Mr. Ruffalo and a bunch of pissed off rooftop solar folks to protest and brought the Silver State to the national news.

I want to assert here that, contrary to what seems to be the popular opinion, this decision was not at all about making the utility rich but about fairness.

Think about this: the total amount the utility can collect is strictly regulated.

There is a certain “revenue requirement” -the amount that was foreseen that the utility should make to cover the cost of service plus some rate of return.

That quantity is pretty much fixed, so it is about who pays a larger share of this revenue requirement.

There has been [of course] a major push back from the rooftop solar companies and some advocacy groups.

Their main argument was that NEM saves money to the utility for a couple of reasons.

First is the avoided transmission losses.

You’ll lose some energy when you transmit it over the lines. NEM generation occurs where it’s consumed so it avoids the losses.

Good point, but this benefit will be limited if a large portion of the NEM generation is exported to the grid. [think: some energy will still be lost if the electrons travel in the grid]

Second, avoided capacity investments.

Again good point, but again limited because the majority of the NEM generation occurs [noon] outside the peak human consumption hours [6pm].

It is hard to store electricity, so the total installed capacity cannot be less than the peak load.

Hence not a lot of capital investments will be avoided because of NEM capacity.

HOWEVER, there are other benefits of distributed solar generation that,

to the best of my knowledge, have not been factored into the decision.

These include:

Diversifying the spatial portfolio [don’t put all you panels to one location because if one circuit next to a large plant breaks you are doomed.]

Better utilization of space [rooftop spaces are useless otherwise plus large scale solar threatens the super cute plants and animals in the desert including the tortoises!]

Solar panels provide insulation to buildings [so they won’t be blasting the AC as much during the summer peak load hours.]

If we want fair policies we have to factor in not just one but ALL of these dimensions.

For this to happen we need to measure them well.

We need good data, statistics, computerized grid models, and computational power for running simulations of different scenarios.

Luckily, it’s 2016 and we have all of them.

We need this because with better batteries, smart grids, and downward trend in the cost of solar panel on the horizon, rooftop solar will become popular again, even in Nevada.

So we should make sure that everything is fair for everyone.

FYI: The existing NEM folks are grandfathered in back to the favorable old rates.

Last thought: I hate having to defend myself like this, but I am a proud tree hugger myself. That’s why I spent many years of my life studying environmental economics. It breaks my heart that poor desert tortoises and many other species have to pay the price of our insanity.

But we are in tough times now.

We are literally at a point where we are about to drive the entire planet to distinction and we have to act fast.

Don’t think about just the US or Germany.

Think about China, India, and other growing economies where people are not as wealthy.

How should they plan to fuel their growing economies in a way that doesn’t destroy us all?

Nevadans will be voting for four ballot measures during this year’s election.

One of them is about energy choice. Ballot question 3 asks voters if they vote yes or no for the “establishment of an open, competitive retail electric energy market that prohibits the granting of monopolies and exclusive franchises for the generation of electricity.”

The text of the question mentions the existence of a monopoly. But how did we even end up with a monopoly utility in the first place?

The answer lies in simple economics. Electricity industry is a canonical textbook example of natural monopoly. It is because we only need one set of transmission lines and one set of distribution lines. Also, a single large power plant tends cost less per kWh than multiple small plants do. So it is cheaper for one company to generate 100 kWh then hundred companies to generate 1 kWh each.

The regulators pretty much strike a deal with the power company with the following terms:

The utility company will have the monopoly status and they will be allowed to cover all their costs from the ratepayers.

In exchange for this, the utility promises to invest in generation, distribution, and transmission capacity to serve everybody in the constituency. They also have to have reliable service where we don’t end up with annoying blackouts and the voltage shouldn’t fluctuate enough to break our appliances. The utility is also required to serve every single customer who wants service regardless of how profitable they are. Additionally, the utility needs to file detailed rate cases where they substantiate their claims of cost increases if they want to increase the rates. Once the rates are locked in, they can’t change it for certain number of years. Last but definitely not least, the utility needs to comply with renewable portfolio standards where a certain percentage of the generation needs to come from renewables sources.

An obvious question would be if we have such a hunky dory setting here why on earth we consider changing it? The answer is again simple economics. The cost of generating electricity at small scale has come down significantly in the past decade. Now for many large electricity consumers it is more economical to generate their own electricity (or buy it from independent power providers) rather than purchasing it from the utility. Because remember, the utility is charging for the stranded costs from older and more expensive technologies.

An important thing to keep in mind is that the utility makes all the infrastructure investment (generation, transmission, distribution systems) even before they can start selling the electrons and billing people. We are talking about really large amounts of cash here. For obvious reasons, in economics lingo all these capital investments are called “stranded costs”.

Here is where it gets all hairy. The stranded costs make up the major portion of doing business in electricity industry. If a large customer wants to leave the utility, it is true that the utility will no longer have to buy fuel to serve that customer. However, the stranded costs will not go anywhere. The utility, per the agreement with the regulator, already planned out the consumption and made the necessary capital investments to serve that customer. The decline in the utility’s cost by not serving this customer is not commensurate with the customer’s consumption. Since the state law and the federal law give the utility the right to charge the remaining customers to cover for all the costs, there can be potentially substantial rate increases to the remaining customers associated with massive exits.

Currently, commercial and industrial customers can leave the utility if they want to by paying what is called the “impact fee”. It is designed precisely to cover for the stranded costs that the utility incurred for each customer.

What this ballot measure wants to do is to make the rule ubiquitous so that anybody who wants to leave can do so.

The major problem is that it does not say anything about how the stranded costs will be recovered.

Who is going to pay for them?

Will the rest of the ratepayers who chose to stay with the incumbent (utility) be stuck with them?

If not, will the utility go bankrupt as a result?

That certainly wouldn’t be good for anyone…

I also didn’t see anything regarding the environmental impact. I assume and certainly hope if anybody is buying electricity from a third party, they should make sure a certain percent comes from renewable sources to comply with the renewable portfolio standard. Otherwise it wouldn’t be fair to the utility.

Not to mention this may add additional administrative costs associated with monitoring compliance. The regulator will have to monitor the compliance of many sellers as opposed to just one.

Opening the electricity market can potentially lower the costs for those who are able to exit economically. But the overall success is not guaranteed. Designing a well functioning market is not cheap and definitely for not the faint of heart. Texas was able to make it work only after putting thousands of hours of legislature time into planning their move. However, many people still stayed with the utility due to inertia (i.e. being too lazy to look for bargains).